Let’s face it: the cost of a college degree isn’t going down.
As those prices go up, a huge number of students are being forced to take out student loans to finance their education. A 2020 report found that on average, borrowers owed $39,351 in loans after graduating.
Because of this, many young adults start in debt.
There are a few advantages to getting student loans, but it’s important to bear in mind that they aren’t right for everyone.
That’s why some families work to plan ahead, so they’ve got alternative options to help their loved ones cover the sky-high cost of education.
In this article, you’ll learn about the pros and cons of student loans, the main types of student loans, and how you can help prepare your loved one for the cost of college.
Pros and Cons of Student Loans
No two students are 100% alike. Everybody has different goals, so different types of financial aid are going to be a better fit for some families than they would be for other families.
Student loans are no different. Taking out loans to help the children you love pay for college or university goes hand-in-hand with its own unique set of pros and cons.
Advantages of student loans
The single greatest advantage of taking out a student loan is that it enables the kids in your life to attend college no matter what your financial situation looks like.
At present, the typical cost for a student living on campus and studying at a public four-year in-state university is $25,864 per year. If the kids you love end up going to a private university, their tuition and fees are going to come in even higher, at an average of $37,200 per year.
If you’re not in a position to provide the children in your life with that sort of cash, taking out a student loan could be the most practical option they have to pay for their education.
Student loans can also be a helpful way to teach young people about financial responsibility.
When you agree to take on a loan, you’ve got to exercise your financial literacy skills to understand how the interest rate and your payment plan will ultimately guide or impact your financial future.
For many young people, having to contend with student loan debt pushes them to make more conservative and responsible financial decisions. It’s also a way for the kids you love to build up their credit — as long as the repayment terms are being made.
Drawbacks of student loans
The major drawback of taking out a student loan is that you or the child you love will be sitting on top of a huge mountain of debt.
US student loan debt is currently at around $1.71 trillion, and that number grows six times faster than the economy does. One in eight Americans are currently saddled with student debt, and the average starting debt for a student after graduation day is $39,351.
Because of that debt liability, another con of student loans is the risk of default.
At any given time, 15% of US student loans are in default — and 11% of students default within one year after graduation day.
That can hurt an individual’s credit pretty badly. There’s also the added risk that a defaulted loan could ultimately go into collections. These scenarios can have lasting harmful effects on a person’s ability to get a car loan, a mortgage, and even a job.
Types of Student Loans
Generally speaking, there are two main types of student loans: federal student loans and private student loans.
To help give you a rough idea of what to expect, we’ll quickly break down the basics of each loan type.
Federal student loans
A federal student loan is a financial product backed by the US government.
The terms and conditions of a federal loan are set by law, and they typically use fixed interest rates. That means if you choose a federal student loan, your interest rate will stay the same for the lifetime of the loan.
Federal student loans also typically have:
- Income-driven repayment plans: Payments are adjusted based on your income
- The possibility for student loan consolidation: Combining multiple loans into one payment
- Loan forgiveness: Having part or all of your loan forgiven, so you no longer owe the money
Direct PLUS loans
A Direct PLUS Loan — or “parent PLUS loan” — is a special type of federal loan that we want to briefly touch on in more detail.
This is a government-backed loan that is offered to the parents of students rather than the students themselves.
If you decide to take out a Direct PLUS loan to pay for a child’s education, you are responsible for repaying the loan.
The maximum you’re allowed to receive is the cost of attendance for a child after subtracting any other sort of financial aid they may be getting.
It’s also important to note that you won’t be able to get a Direct PLUS loan if you have an adverse credit history. You’ll need to pass a credit check to gain approval on a Direct PLUS parent loan application.
Private student loans
Private student loans are offered by private lenders like banks, credit unions, or other state-based organizations.
The terms and conditions of private loans vary by lender, and they aren’t set by law like federal loans. Instead, the banks or institutions lending you the money get to decide if and when the rules change.
Private student loans are typically more expensive than federal loans in the long run. One reason for this is that not all private loans have fixed interest rates. That means a borrower’s interest rate could go up or down in the future based on market conditions.
Another reason is that private loans tend to lack a lot of attractive features of federal loans, such as income-based repayment and loan forgiveness.
That being said, it is sometimes easier to get a private student loan because they aren’t always need-based.
How to Get Student Loans
If you or your loved one is considering applying for a student loan, there are different application procedures for each loan type.
The Free Application for Federal Student Aid (FAFSA) form is the universal application that students use to apply for federal financial aid or financial aid from their college or graduate school.
It’s easy to fill out a FAFSA online, but there are several different deadlines you’ve got to contend with. The federal FAFSA deadline is June 30 every year — but your state may have its own deadline for priority consideration. Likewise, most colleges have their own deadlines.
To apply for a Direct PLUS loan, you’ve got to be the parent or guardian of an eligible dependent undergraduate student.
You can apply online using a fairly straightforward form, and it normally takes around 20 minutes to complete. Those details will then be shared with the child’s college or university.
To secure a private student loan, you’ll need to complete a different application for each lender.
You’ll likely be asked for a range of details on each application form, and you’ll also typically need to undergo a credit check as part of your loan application.
How Does Student Loan Forgiveness Work?
In some situations, you might be able to apply for student loan forgiveness. Under loan forgiveness, the remaining balance of your federal student loans is written off.
Loan forgiveness only applies to federal student loans. Private lenders don’t generally offer loan forgiveness.
Federal Student Aid offers a number of loan forgiveness schemes for various groups. For example, teachers that spend five consecutive academic years working full-time in a school can have up to $17,500 in student loan debt forgiven.
Similarly, if you’re in a really low-paying job, you can ask to repay your loans under an income-driven repayment (IDR) plan.
All of Federal Student Aid’s IDR plans offer loan forgiveness after a certain number of payments have been made.
To be honest, it can get complicated. So if you really want to learn about loan forgiveness and how it applies to each situation, you’re going to want to consult the Federal Student Aid website.
How to Help Your Loved Ones Pay for College
Don’t like the sound of all these complicated rules, interest rates, and student debt? We don’t blame you.
That’s why more and more families are turning to custodial accounts as a way to pay for college instead of taking out loans.
A custodial account is an investment vehicle you can use to save for the kids that are important in your life. It enables you to set up an account for a minor beneficiary, and you, as the adult, then act as the custodian over the assets until that beneficiary comes of age.
In most states, the age of majority is either 18 or 21. Unlike 529 accounts, custodial accounts don’t have rigid withdrawal rules.
As soon as the child beneficiary comes of age, they can use the funds on whatever they wish — meaning they can pay for extra college expenses like travel, entertainment, or off-campus accommodation.
There’s also a tax benefit when using a custodial account to pay for college because the assets in the account are taxed at the lower child’s rate up to a certain threshold.
But the biggest benefit of using a custodial account to save for a child’s future college expenses is that the assets in that account aren’t borrowed. When the child you love comes of age, that money will become theirs to use to pay for college without having to take out thousands of dollars in loans.
That not only enables the children you love to benefit from financial freedom now, but it also gives them the opportunity to start off on the right foot after graduating.
Let’s Start Investing
At the end of the day, student loans work for a lot of people. But if you want the children you love to graduate from college without a mountain of debt looming on the horizon, you should consider investment alternatives like a custodial account.
Considering a custodial account? You’ve got to check out EarlyBird.
EarlyBird helps you to set up an easy-to-use custodial account for the children you love, and you can choose from a range of investment portfolios that will fit in with your savings goals.
But don’t just take our word for it. Download EarlyBird in the app store today to see for yourself how you can start saving for a child’s future college expenses.
This page contains general information and does not contain financial advice. All investments involve risk. Any hypothetical performance shown is for illustrative purposes only. Actual investment performance may be different for many reasons, including, but not limited to, market fluctuations, time horizon, taxes, and fees. Please consult a qualified financial advisor and/or tax professional for investment guidance.